Definition: Balance of trade is defined as the measure of the difference between the monetary value of the exports and imports of a country for a particular period. It is a significant constituent of the balance of payments account and measures every account involving overseas transactions.
What is the Balance of Trade?
Balance of trade is a difference that occurs in a specific period in between the value of a country’s exports and imports. It is also the largest component of the BOP or the balance of payments of a country. Balance of trade BOT is also popular as the trade balance.
The positive trade balance is the indicator of the trade surplus while on the other hand, the negative trade balance is associated with the trade deficit. The balance of trade is also an integral component in finding the current account of a country.
The trade balance of a country also has a large chunk of shares in the current account. A nation records a trade surplus when the exports are more significant than the imports, and when that is the other way around, that is when the imports are more significant than the exports, it records a trade deficit.
This means that the flow of imports and exports is calculated for a particular period, so the trade balance does not revolve around the misconstrued idea that there is a balance between a country’s imports and exports.
Understanding Trade Balance
A country arrives at the balance of trade or trade balance by subtracting its imports from its exports. It is sometimes referred to as net exports or commercial balance. Before any good or service enters the country, it first needs to be checked at the customs office. All the items arriving or leaving the country, in other words, the imports and exports, are measured thoroughly.
As mentioned earlier, trade balance, as a part of a nation’s current account, measures what has been earned on its assets in foreign countries or, to put it simply, its current net income from the asset position in foreign countries’ foreign assistance.
A trade surplus also termed a positive trade balance occurs when exports are more in value than imports, and a trade deficit occurs when the imports exceed the exports. A trade deficit is not always damaging, particularly when a country imports goods and services massively and at the same time injects heavy investment into the economy. Likewise, a trade surplus does not always give an edge to the country over its international partners; it can work against an economy if the given country intends to protect its domestic industries and therefore does not allow for healthy international competition.
The physical balance of trade is equal to the total amount of raw materials or inputs consumed by an economy. There is an entire cycle of trade that follows. The developing countries export raw materials and other intermediate goods to the developed countries, which use these items as inputs to produce the outputs or the final products. These final goods are then exported to developing countries. This shows that developed nations have a more significant physical trade deficit as they rely heavily on the raw materials from developing nations.
How is the Balance of Trade Calculated?
The formula for calculating the balance of trade is as follows:
Balance of Trade = Value of Exports – Value of Imports
The symbol for exports is ‘X’, and that for imports is ‘M’.
Positive and Negative Tade Balance
In case a country is exporting greater value than the value it is importing then it would be termed as a trade surplus or positive trade balance.
While on the other hand, in case a country is importing more than it is exporting then it would be termed as a trade deficit or negative trade balance.
Factors Affecting Balance of Trade
Several factors influence the balance of trade of an economy
- Fluctuations in currency and foreign exchange rate.
- Cost of factors of production like land, capital, labor, etc.
- Taxes and incentives present in the country where the goods and services need to be exported.
- There are certain restrictions based on the type of trade agreement – it could be multilateral, bilateral, or unilateral.
- Availability of inputs like intermediate goods, which are required for producing final goods.
- Cost of raw materials and all the necessary inputs.
- Lack of sufficient foreign exchange for making import payments.
- Prices of the goods produced domestically.
- Hurdles due to non-tariff barriers like a country’s standards set for environmental protection.
Key Points associated with Trade Balance
Here are some essential bullet points to take note of
- Every country produces some goods and services, and when these items are sold abroad, they are termed as exports for the domestic country. For instance, if a trader of cotton in a given country wants to sell it to a manufacturer of clothes in a foreign land, he can do so, and then. As a result, cotton will be considered an exported good as it is leaving the domestic country.
- On the other hand, all the goods and services produced in an international country but purchased by the people living in the domestic country are termed imports. For instance, if a person goes on a trip to a foreign country, then all the incidental costs, including the cost of transportation and hotels, will be considered imports. Any good or service bought by a resident of a country from abroad will be categorized under the heading of imports.
- For drawing a comparison between a country’s economy and its international trade partners, the trade balance is calculated by subtracting the imports from the exports.
- Nations having a considerable trade deficit engage in borrowing money for paying for the goods or services, while those with a trade surplus help those with a trade deficit by lending money.
- The trade surplus is due to the exports being more in value than the imports. Several countries consider trade surplus to be better than trade deficit, and therefore they have adopted trade policies that ensure more exports are made. They feel it to be necessary for improving the standard of living of their residents and the performance of their economy at large.
- In reality, a trade deficit, if accompanied by proper investment in the economy, helps the economy to develop enormously.
- Countries tend to encourage more export by fuelling the demand when there is a recession to create more jobs. However, in the case of inflation, countries aim to reduce exports and increase imports to bring the prices down.
Difference Between Balance of Trade and Balance of Payments
‘Balance of payments’ and ‘balance of trade’ are not the same thing. Some of their notable differences are-
- Balance of payment is a broader term and involves the balance of trade. It includes all the investments made abroad and the net income earned from those investments.
- Balance of trade includes only those imports and exports visible; for instance, when some merchandise is exported or imported, it will become a part of the balance of trade. But in the balance of payments, all those imports and exports that are visible and invisible will be included.
- Balance of trade records only revenue items instead of the balance of payments that shows both capital and revenue items.
- A trade deficit in the balance of trade may not be reflected in the balance of payments. A nation with a trade deficit can have a balance of payments surplus.
- A surplus in the balance of payments can easily balance out the deficit in the trade balance, but vice versa is not valid.
Nearly 60 nations out of all the countries in the world have recorded a trade surplus.
China is an excellent example of a country where there has been an increase in the trade surplus even in the middle of a pandemic. The pandemic forced the trade worldwide to contract, thus adversely impacting the economies; however, this seems not to have affected China as it not only reported a trade surplus but also saw a stark rise in the amount from the previous year.
In 2019, Armenia ran a trade deficit of more than $200 million. It recorded the highest deficit of all time in the year 2003. This has been attributed to the ongoing disputes with its neighboring countries.
The United States is another country that has been consistently reporting a trade deficit. It has hardly ever run a trade surplus.
The scenario in 2019 was such that Germany reported the highest trade surplus as per the balance of the current account, with Japan and China occupying the second and third positions, respectively. On the other hand, the United States accounted for the highest trade deficit. The United Kingdom came second while Brazil came third in running a large trade deficit.
On the concluding note, it is clear that the balance of trade is the difference between a country’s exports and imports. It is also known as the international trade balance, the net exports, or commercial balance.
Now, after understanding the concept of BOT, what is your definition of balance of trade? Share with us in the comment section below.